Sunday, June 07, 2009

In this NY Times op-ed, Yale economics professor and housing market guru Robert Shiller splashes some cold water on the recent housing market fervor in such places as Arizona.

Why Home Prices May Keep FallingHOME prices in the United States have been falling for nearly three years, and the decline may well continue for some time.Even the federal government has projected price decreases through 2010. As a baseline, the stress tests recently performed on big banks included a total fall in housing prices of 41 percent from 2006 through 2010. Their “more adverse” forecast projected a drop of 48 percent — suggesting that important housing ratios, like price to rent, and price to construction cost — would fall to their lowest levels in 20 years.

Such long, steady housing price declines seem to defy both common sense and the traditional laws of economics, which assume that people act rationally and that markets are efficient.

A national home price decline of 48 percent would imply a decline of, what, about 80 percent in Phoenix? That may be a very efficient and rational market.

He goes on to explain why home price declines go on for much longer than most people really understand, especially those who think they're snapping up such bargains today.

Several factors can explain the snail-like behavior of the real estate market. An important one is that sales of existing homes are mainly by people who are planning to buy other homes. So even if sellers think that home prices are in decline, most have no reason to hurry because they are not really leaving the market.

Furthermore, few homeowners consider exiting the housing market for purely speculative reasons. First, many owners don’t have a speculator’s sense of urgency. And they don’t like shifting from being owners to renters, a process entailing lifestyle changes that can take years to effect.

Among couples sharing a house, for example, any decision to sell and switch to a rental requires the assent of both partners. Even growing children, who may resent being shifted to another school district and placed in a rental apartment, are likely to have some veto power.

In fact, most decisions to exit the market in favor of renting are not market-timing moves. Instead, they reflect the growing pressures of economic necessity. This may involve foreclosure or just difficulty paying bills, or gradual changes in opinion about how to live in an economic downturn.

This dynamic helps to explain why, at a time of high unemployment, declines in home prices may be long-lasting and predictable.

It used to be conventional wisdom that, unless you were financially strapped, once you became a homeowner you would forever be a homeowner. If you were transferred from one town to another, you'd put your house up for sale, go out to the new place, look around for a few days, buy a house, and move in.

That seems to be changing and one of the most important reasons is that people can't sell their existing houses - at least not at the price they want.

It will be interesting to see if the U.S. housing bust fundamentally changes the way Americans think about home ownership.

Shiller says we'll have continued declines AND... "steady housing price declines seem to defy both common sense and the traditional laws of economics, which assume that people act rationally and that markets are efficient".

So Shiller does NOT think that people act rationally or that markets are efficient. Your saying markets are not efficient or wholly rational does not debunk Shiller, it buttresses him.

Shiller's article is yet another example of how people still don't get it when it comes to housing prices. To begin with, he doesn't address the fact that rational people would not hock themselves up to the eyeballs with toxic mortgages they clearly cannot afford in order to pay grossly inflated prices. At the peak, the median cost of a home was at least TEN TIMES the median household income; no sane, responsible lender would give a mortgage on that basis and no sane, responsible buyer would spend that much. When a bubble bursts and prices drop, it does not mean that prices now become "depressed;" rather, it is a CORRECTION back down to more realistic levels.

Housing prices will continue to fall for a long time for the same reason as they did in Japan; they rose to the point of being way beyond people's affordability and therefore became unsustainable. They will fall gradually not only because most people still buy their houses to live in and are not going to give up their homes if they can avoid it, but also because in any given year only a small percentage of people buy or sell their homes, so you still have a majority of homeowners who purchased their homes before the bubble at much lower, more affordable prices.

It doesn't take a genius to figure this out. The apparent stubborn clinging to self-delusion by rationalization and "analysis" of irrelevancies, and the lack of common sense displayed by even our supposed "best and brightest" leaves little doubt as to how we landed in this economic mess.